Education For Thinking Traders

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There is, right this moment, a man in my office having a mental breakdown. I don’t even know his name – he’s some engineering manager in a function I rarely deal with. I have no idea what caused the breakdown – merely that he’s sobbing at the top of his lungs from his office “I don’t know what my fucking problem is!” and similar vaguery. Thankfully a co-worker who’s better at this sort of interpersonal relationship thing than I am has closed his office door and gotten him a tissue. I say thankfully not because his breakdown is resolved but because I no longer have to listen to him. Harsh? Maybe, but read on.

Meanwhile, another guy across the office is having an argument with his wife about buying the expensive backpack at REI vs the cheap one at Walmart. He’s in favor of the Chinese cheepie. She’s in favor of the gold plated one from REI (which for all I know may also be from China). Given the tenor of the conversation, I fear his marriage is not long for this world regardless of which backpack they buy. But mostly I just want him to shut the fuck up about backpacks or at least use his indoor voice. Personally, I’d be embarrassed to spend half an hour arguing about a $50 consumer goods purchase and wouldn’t want anyone to hear it. But shame doesn’t seem to be a major gating factor here.

Now, given my current circumstances, you want to guess how much work I’m getting done right now? If you guessed “not a damn thing” you win a prize. Continue reading →

About two weeks ago, I stumbled onto something that I frankly thought didn’t exist. It appears that I’ve found a pricing equation type inefficiency in a major derivative market. It’s not quite a pure arbitrage, but it’s not far off. The profits to be made appear to be in the 7-8 figure range, and the capital and execution capability required to make them is surprisingly low.

I would very much like to write about the topic as it would certainly be the most interesting material to appear on this blog to date. But the fact of the matter is that the opportunity is big enough to enrich a few people, but not a few hundred people. Having dedicated more than a decade of my life to the pursuit of trading profits, I have to see this through to a conclusion. And I’m going to have to do it without the readers of this blog being in the loop.

So unfortunately you’re going to see a lot fewer posts out of me. I’ll update the speculative alternatives portfolio occasionally. If the bug strikes me to write something else, I will. And when this is all over one way or the other I’ll have a cool story to tell (tentative title if I make millions: “Wall Street Can’t Add”). But in the mean time I’m going to be scarce. Wish me luck…

When developing trading systems, one of the first things you have to deal with is a high level decision: are you designing a method that trades most or all of the time, or only sporadically? Both approaches are potentially valid, but they require different steps during system design. Continue reading →

With the demise of Google Reader, it seems clear to me that the writing is on the wall for RSS as a push technology to connect people to this blog. Not that some people won’t continue using RSS, and I’ll keep supporting it, but clearly it’s no longer a way to reach many people. Which leaves me with two choices for an alternative: Twitter or Facebook. Neither seems particularly palatable to me, but Twitter looks like the better of the two in terms of being a simple, transparent pass through. Enter the new Off-Road Finance twitter account. My current plan is to simply use it to notify people when I’ve sent out a new article. So if you’re on twitter and follow this site, follow me to get the latest updates.

If you’ve been following this blog since the beginning, you may know that I take a fairly dim view of investment. If you haven’t read the linked article, you’ll want to do so before continuing or the rest of this won’t make much sense.

Today’s market news is that the Dow Jones Industrial Average (DJIA) made new record all time highs, eclipsing the previous highs from 2007. This is, as news goes, only sort of important The DJIA long ago ceased being particularly relevant when compared to the S&P 500. The concept of Dow industrials and comparing them to DOW transportation stock to generate market signals (that’s “Dow theory” for the uninformed) has more or less been laid to rest by modern confusion about what constitutes an “industrial” stock. For example Microsoft is part of the DJIA, but most of their products are licensed bits, not physical things delivered via a truck or rail car. As a result their delivery won’t trigger business for transportation firms, and the whole point of Dow theory really doesn’t apply. Given that, the DJIA is now pretty much a joke. It’s just 30 big US stocks. None the less, the DJIA lurches on like an unwanted extra in a zombie movie. And of late, it’s been lurching up.

Contrast the DJIA’s behavior to my theory linked above about investing in the US. The theory is basically that the supply of investments is proportional to working population and the demand for investments is proportion to late-career working population. In other words, the older the work force the more expensive/overpriced investments will be. My logic was that as the baby boomer demographic (by far the largest in the US) hit retirement in 2000 and on average started to divest assets, asset prices would peak and start to fall in real dollar terms. So a new high in the DJIA raises the question: am I flat out wrong? Continue reading →

One of my favorite psychology ideas comes from the poker literature – specifically Mike Caro’s “threshold of misery”. Mike’s point, paraphrased, is that there’s a difference between how bad a situation is objectively and how bad people feel about their miserable circumstances. Sure, as a situation gets worse, we feel worse. But eventually we hit a point where they feel about as shitty as is possible. Analytically speaking the situation can get worse, but there’s only so bad you can feel about it. That boundary is the threshold of misery. Continue reading →

In the wake of the economic scandals of 2008-2009 and more recent events like the JP Morgan’s “London Whale” losses the media has directed substantial scrutiny at trader compensation and the role it plays in trading losses. This discussion has focused on one point: traders who are paid primarily via bonuses are paid both for performance (which is arguably good) and for volatility (which can cause havoc).

Consider a trader managing a $100M portfolio who is paid $300K per year plus 15% of each year’s profits. Clearly this trader has what amounts to a cash settled call option on the portfolio. If the portfolio makes money, he gets 15%. If it loses money, he loses nothing. It’s easy to see how this could warp the trader’s behavior in the direction of taking excessive risk anytime the portfolio was close to break-even as the year end approached. Taking a 20% coin flip at the end of a break-even year would result in an expected profit of $1.5M for the trader (half the time he wins $3M, half the time he gets no bonus) and an expected loss of $1.5M for his employer/investors (who would win $17M after fees half the time, and lose $20M the other half of the time).

This phenomenon is undeniably real, and anyone designing the compensation packages for traders would be wise to take it into account. But I would argue the media discussion of the topic misses one central fact: traders don’t like to get fired. This rather common-sense aversion on their part goes a long ways towards explaining certain market events. More importantly it can directly put money in your pocket once you know what to look for. Continue reading →

Current value of the portfolio as of today is about $32,020 – a 6.6% gain from portfolio inception.

I want to discuss a little how the portfolio has been doing. We’ve gone 6 months now and held 13 stock positions (two still open) and changed the direction of our gold position twice. Continue reading →

One thing I hope I’ve gotten across with this blog is that there are lots of ways to trade successfully. It’s not that there’s one magical formula, and once you have that formula it rains money. Rather, there’s a lot of little things that you can do wrong or right. This is very much true in futures scalping. If you do enough of them right, you start to make money. As you get more right, you can make more money with less downside risk. Here’s a list of 21 good ideas that helped me move from being a losing trader to a winner. I’m not going to provide excruciating detail on each aspect right now. Just enough info to get you thinking about a given topic. Continue reading →

Nothing on this blog is a trade recommendation. There is substantial risk of loss in all trading. I am not soliciting funds for any fund or pool, and will not take them if you try to give them to me. I do not have any financial credentials or licenses – I’m just another guy with an opinion.